FCA private market valuation review finds room for improvement

What does this mean?

The FCA’s review was conducted in two phases, involving analysis of questionnaire responses from an initial sample of 36 firms, followed by further in-depth work with a subset of firms.

The FCA’s review findings focus on areas where the regulator found firms have room for improvement in their policies and processes. The findings can be grouped as follows:

• Governance of valuation processes: Firms have generally implemented governance processes, including having valuation committees in place that are responsible for valuation decisions. However, firms’ recordkeeping was not always complete, preventing the FCA from having confidence in the effectiveness of committees’ oversight. The FCA also found that firms with robust valuation processes could evidence independence, expertise, transparency and consistency across their practices.
  

• Identifying and managing conflicts of interest: Firms recognised and managed conflicts related to fees, remuneration, and managing potential volatility in a fund’s valuation, but often had not sufficiently considered and documented other valuations-related conflicts. These include conflicts related to investor fees, asset transfers, redemptions and subscriptions, and marketing of unrealised performance. Firms did not consistently identify and document potential conflicts related to secured borrowing against a fund’s net asset value (NAV).

• Ensuring independence during valuation processes: While some firms were able to clearly demonstrate functional independence in their valuation processes, in others this function performed a more administrative and operational role. At some firms, investment professionals were involved in the valuation task, and participated as voting members of valuation committees. While the FCA acknowledged that such individuals’ expertise is important, it will follow up with firms to understand whether this practice introduces any compromises to independent oversight and challenge.

• While all firms involved in the second phase of the FCA’s work had documented valuations policies, not all firms’ policies detailed the rationale for selecting valuation methodologies, the required inputs and data sources, and a description of the safeguards in place to ensure the functional independent performance of the valuation task.

• Frequency of valuations: Valuations were most commonly conducted on a quarterly basis, with a portion of firms conducting more frequent (monthly) valuations. For out-of-cycle valuations, most firms did not have defined quantitative or qualitative thresholds for triggering ad hoc valuations and often waited for valuations to flow through at the next valuation cycle. However, a few firms had formally incorporated ad hoc valuations into their processes including identifying the types of events that would trigger an out-of-cycle valuation.

• The FCA also reviewed the consistency of how firms applied valuation methodologies, where it found that firms were commonly applying consistent methodologies across asset classes. The regulator identified that using another methodology to sense check valuations and using industry guidelines to ensure firms’ approaches are in line with standard market practice represents good practices for the sector.

What do firms need to do?

The FCA’s review provides a clear set of expectations for firms regarding private market valuation processes and policies. All firms that are active in private markets should consider their current policies and processes against the FCA’s findings and good practices to identify and address any gaps.

Firms should be mindful of the FCA’s expectations, as set out in its recent  Supervisory letter for asset management and alternatives firms, that firms’ procedures will need to evolve and be updated as private markets continue to develop. 

Firms should consider establishing governance processes to implement the actions the FCA expects firms to take in response to this publication. In particular, firms should be prepared to engage with the FCA on further planned work on conflicts of interest in private markets and be able to demonstrate that they have effective policies and processes in place to meet current requirements, including through governance bodies and reviews by the three lines of defence. 

For firms that were involved in the mult-firm review, the FCA confirmed that where firms did not meet its expectations, it will conduct targeted follow-up work. This is likely to involve data requests and further interactions with the regulator.

Next steps

In addition to informing the forthcoming AIFMD review, the FCA will use the findings of this multi-firm review to inform other workstreams. This includes the Bank of England’s work on Non-Bank Financial Institutions, and IOSCO Committee 5’s review of the 2013 Principles for the Valuation of Collective Investment Schemes.